Protect yourself against falling property prices2:06

The key to making an investment property stack up financially is having tenants paying rent.Source:Supplied

THE future health of the Australian residential property market seems to be a very contentious and hotly debated topic at the moment.

The recent Reserve Bank board minutes showed it was quite comfortable with the state of the property market while some international commentators are predicting an imminent crash in values.

Rather than speculate on who will be right or wrong, the more important thing is to understand the major signals which could point to a change in the property market.

Here are our six warning signs to watch out for.

1. Rising interest rates

Borrowing money has never been cheaper. Record low interest rates have meant property buyers have been borrowing more for less. It has been a golden period for anyone wanting to get into the property market.

But this period of easy money can lead to a financially deadly “debt trap” for those who overdo it. A rise in interest rates can have a devastating impact on an over geared borrower … and it can sneak up on you.

For example, a 2 per cent rise in interest rates on a 4 per cent home loan doesn’t sound much until you realise it would mean a 50 per cent jump in repayments.

There are no signs of an imminent rise in rates in Australia at the moment but when it does come be wary of the impact of distressed selling coming onto the market from those who have over borrowed.

The higher the auction clearance rate the healthier the market.Source:News Corp Australia

2. Rising unemployment

With 25 consecutive years of positive economic growth, the job market has been pretty solid for quite some time and unemployment has been relatively low. That has been good news for the property market because stable employment gives buyers the confidence to borrow and get into the market or trade up.

Just look at what happened overseas with the Global Financial Crisis (which we generally avoided in Australia) when property prices in Europe and the US fell by 30-50 per cent. A solid economy and job market is crucial to a good property market.

3. Falling auction clearance rates

Auction clearance rates are a regular, consistent barometer of property market health. It’s an indicator on the balance between buyers and sellers, which is the fundamental supply and demand foundation of all property markets.

as it indicates there are plenty of buyers competing for stock on the market. When clearance rates fall it indicates fewer buyers and more sellers which is likely to see property values fall or stabilise.

For example, Sydney and Melbourne auction clearance rates over recent months have been around the 70-80 per cent mark while Perth has been around 50 per cent.

An important driver of property values is the investment market. Investors buying property for both capital growth and income from rents.

The key to making an investment property stack up financially is they must have tenants paying rent. Rising property vacancy rates (the number of empty properties) means there aren’t enough tenants to go around so investors will either have to slash their rents to attract tenants or sell the property because the returns don’t justify the investment.

This combination will push values down because more stock will come onto the market and lower rents mean the property isn’t as attractive as an investment as before.

5. Falling rental yields

Linked to increasing rental vacancy rates. A property is valued based on the rental income it can produce and its capital growth prospects from rising values.

If vacancy rates rise, then landlords will have to lower their rents to attract tenants otherwise the property will be vacant and earn no income. No, or lower, rental income means the property isn’t as valuable and other potential investor buyers won’t pay as much.

6. Above average construction numbers

Property is fundamentally about demand and supply. Building just enough properties to satisfy demand so there is competition between buyers to underpin valuations.

If construction outstrips demand then values will fall as sellers compete to attract buyers by lowering prices to make their property more attractive.

That’s the current concern about the Melbourne, Sydney and Brisbane inner city home unit market. A huge amount of construction is underway and there are fears that when these developments are finished, and come onto the market, there will be an oversupply and values will fall.